Quite plainly, it’s illegal, and the MTA staffer who gave the cities the go-ahead should have known so. The whole idea of a transportation fund is to keep it separate from the general fund.

There are reams of laws and regulations preventing government agencies from transferring dedicated fund $$ to the general fund. Governments try to find loopholes all the time. Auditors keep shutting them down.

As a concrete example from my own experience, state governments will often try to inflate charges for centralized computer services to agencies receieving federal funding. This has the effect of subsidizing computer services for agencies dependent on the state’s general fund. The feds know all about this of course, and make the state’s central computer service agency jump through all kinds of hoops to prove they aren’t doing it.

This is a terrific example in state and local public finance. It may well be more efficient for governments to trade away their restricted (conditional) grants for unrestricted (unconditional) grants. The transport funds would then go to the localities who have more valuable transport projects while the cities who sell their grants would spend the money on projects which have higher value than their local transport projects. This is assuming local officials in the buying and selling communities act in the best interests of their communities, admittedly a stretch. (See below.)

Restrictions (conditions) are usually put on block grants because the higher levels of governments want to influence lower levels to do particular things (e.g., spend money on schools or roads or welfare). In this case, the federal government should want the local governments, which are in deep financial trouble, to spend money on just about anything that they wish to spend on that would benefit their constituents. Congress I think foolishly put too many conditions on the spending.

Now obviously there are problems with this argument: governments that use the stimulus money to pay higher salaries to corrupt officials aren’t helping much. Furthermore, spending on things like extending unemployment insurance (at the state level) is better than many other types of spending (which might be done at the local level). However, it is quite likely that once you decide to give the money to local governments, those local governments know better how to spend the stimulus money effectively than higher levels of governments.

If we believe that local government officials are just plain corrupt, then the embezzlement charge from Bob Knaus in a comment above makes more sense. However, local officials know better how to spend the money effectively and may well do so. And in the current crisis, it may be harder for local officials to get away with corrupt dealing.